Commentary

Euro may be the ‘rock star’ of currencies

Commentary: The down days for the euro may be over

By

HowardGold

Columnist

NEW YORK (MarketWatch) — This week the self-styled global elite and their accompanying media hordes gather in Davos, Switzerland, for several days of schmoozing and pontificating about the state of the world in 2013.

In many ways, things are better than in 2012. Though unemployment remains high in some countries and the global recovery looks fragile, some big political uncertainties (like the U.S. election) are off the table, and the dysfunctional U.S. Congress has stepped back twice from the fiscal brink.

But most important, the euro zone doesn’t look like it’s going to implode. In fact, the Economist reported, “the invalids in Europe’s medical ward are making a remarkable recovery.”

I noted with some surprise in my column last week that the southern European debtor countries — the “invalids” of Italy, Spain, and Greece — have been among the best-performing stock markets in the world over the last few months.

But they’re not the only big winners from the Old Continent in global markets; among global currencies, the euro, has quietly mounted an impressive comeback of its own.

Since last July 24, when it traded below $1.21 (near its 2010 low below $1.20), the euro has gained 10%, to $1.33, as of Wednesday. That’s a big move in the currency pit.

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(3:16)

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And it most likely will continue. In fact, said Axel Merk, president of San Francisco-based Merk Investments, which runs currency mutual funds, the euro may become the “rock star” of global currencies.

OK, I’ll give you a minute to scrape your jaw off the floor. But consider this: Merk thinks that the euro is not just the “least bad” of the major currencies. No, the European Central Bank (ECB) is managing the euro well, he said, and the single currency’s valuation remains attractive, even after its recent move.

“Everybody hates the ECB, but we think they’re the poster children … for how to do it right,” Merk told me in an interview.

First came ECB president Mario Draghi’s now-famous speech last July in which he pledged to do “whatever it takes to preserve the euro.” That caught hedge-fund short-sellers flat-footed and sparked the big rallies in European stocks and euro that have lasted until this day.

Peter Coy of Bloomberg BusinessWeek called it “the speech that saved Europe.”

Actually, as Reuters pointed out, “Draghi was in no position to guarantee ‘whatever it takes.’” But after weeks of wrangling, he announced the ECB was prepared to buy “unlimited” amounts of bonds of even the weakest European countries.

That — and a surprisingly successful Greek debt deal in December — helped rates in Spain and Italy plummet. Both countries’ sovereign 10-year bonds now yield two-and-a-half percentage points less than they did in July. Hence, their stock markets’ rally and the euro’s rise.

Now, said Merk, the ECB isn’t “printing” money by adding to reserves as the U.S. Federal Reserve and Bank of Japan are doing. (He expects the Bank of England to step up its stimulus soon.) It hasn’t had to buy distressed bonds, either.

“The ECB has a far more rational approach,” Merk continued.” The ECB’s balance sheet will be shrinking.”

“That’s because some banks have indicated they will pay back early part of the 1 trillion euros in three-year loans taken from the ECB” as part of rescue operations, he wrote recently.

And if yields remain low, the ECB may accomplish with Italian and Spanish banks (and other European banks that invest in their bonds) what Fed chairman Ben Bernanke and Treasury Secretary Timothy Geithner pulled off here in 2009: Persuade private investors to buy the paper of deeply troubled financial institutions.

Meanwhile, Merk’s looking for a much weaker yen as new Prime Minister Shinzo Abe pressures the Bank of Japan to inflate its way out of a two-decade-long morass. Abe will name three appointees to the bank’s board, including a new governor, and they’re all likely to be dovish. That will complement a big new economic-stimulus program.

Given the country’s 220% debt-to-GDP ratio and its move to a current-accounts deficit, Merk thinks the yen’s safe-haven status is in jeopardy. The yen is “doomed,” he wrote.

Also, Merk expects the Fed to continue its loose monetary policy through 2013 and beyond. “Just about everybody on the [Federal Open Market Committee] is dovish this year,” he said. “We’re going to continue printing money in the U.S.” He worries that President Obama and Congress won’t do enough to take on debt and entitlement spending, and the U.S. economy will remain in slow-growth mode.

Not that Europe will have smooth sailing. Italian elections in February and German elections in September could be bumps in the road, as could renewed financial or political instability in Greece. And continued economic stagnation in several countries, including France, may produce unexpected social dislocation that has the potential to widen the fault lines in the European Union.

But Merk is optimistic the euro will continue advancing — even beyond $1.40. I agree with him, but I’m waiting for a pullback before I buy European markets or a modest position in the Currency Shares Euro Trust ETF
FXE, -0.63%
as part of a small currency hedge in my portfolio.

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